The Most Important Economist You’ve Never Heard Of

Sept. 6 (Bloomberg) -- Ronald Coase, who died this week at
the age of 102, was one of the greatest economists of the 20th
century. His impact on academic thought and public policy is
incalculable.

In 1991, Coase won the Nobel Memorial Prize in Economic
Sciences in part for a theorem he set out in a 1960 article that
is, by a large margin, the most cited law-journal paper of all
time. The Coase theorem produced a revolution in both thought
and public policy.

His target was the great British economist Arthur Cecil
Pigou, who contended that if a polluter is emitting smoke, and
thus causing injury, the best response is to make the factory
owner pay for the injury or to impose a corrective tax.

Coase said Pigou failed to see “the reciprocal nature of
the problem.” Suppose that a very noisy factory is causing
legal injury to a doctor operating next door. Under Pigou’s
approach, the factory should be required to pay damages to the
doctor. But Coase pointed out that we could also make the doctor
bear the cost. His central insight was that if people can
bargain with one another, and if it isn’t costly for them to do
so, it just doesn’t matter who is required to pay: People will
negotiate their way to the efficient solution. This is the Coase
theorem in a nutshell.

Here’s the basic idea: Suppose that under the law, the
factory has to pay damages to the doctor. If the doctor can
avoid injury by moving his office a few blocks away, and if he
can do that cheaply, the factory will pay him to move, and
that’s what he’ll do.

Doctor’s Cost

Now suppose that under the law, the doctor bears the cost.
If he can avoid injury by moving his office a few blocks away,
that’s what he’ll do. The legal rule won’t affect the outcome.
The example is perfectly generalizable. The same analysis holds
whenever people are harming each other (but are in a position to
bargain).

Coase recognized, of course, that it will often be costly
for people to negotiate with one another. If a factory emits
pollution that affects thousands of people, a bargain is
unlikely. Coase’s analysis suggests that when people can’t
negotiate, policy makers should try to identify the agreement
they would reach if they had been able to do so. To identify
that agreement, they have to analyze the benefits and costs of
the harm-producing activity. Coase emphasized that “all
solutions have costs and there is no reason to suppose that
government regulation is called for simply because the problem
is not well handled by the market or the firm.”

Coase’s argument has a dramatic background. It was
foreshadowed by a brief passage in an earlier essay he wrote on
telecommunications. That passage caused much consternation in
the University of Chicago economics department, whose members
invited him to come to Chicago to discuss his “error” in
person.

At the beginning of the session, the audience was
essentially unanimous: Coase was wrong. Milton Friedman, a
fierce debater and eventual Nobel Prize winner, led the charge
against him. It was a clash of the titans, or perhaps an
academic mugging: Coase stood alone.

As Coase told the tale, “I don’t know whether you’ve had a
conversation with Milton Friedman, but an argument with Milton
Friedman is a pretty strenuous affair.... But when at the end of
whatever the time was -- say, an hour -- I found I was still
standing, I knew I’d won. Because if Milton can’t knock you out
in a few rounds, you’re home.” At the end of the evening, the
group was again unanimous: Coase was right.

The Coase theorem has helped to spur market-oriented
approaches in countless areas, including telecommunications
(where auctions are in now widespread use) and environmental
protection (where command-and-control approaches are often
rejected in favor of systems that allow for trading).

Affecting Regulation

Coase’s work has also helped reorient thinking about
regulation in general, in part by emphasizing the importance of
private flexibility, cost-benefit balancing, and careful, dogma-free empirical analysis (for which Coase made many pleas).

True, the theorem has run into some serious objections,
including from behavioral economists and those who emphasize
distributional considerations. But it continues to provide the
starting point for inquiry into countless social problems.

“The ideas of economists and political philosophers, both
when they are right and when they are wrong, are more powerful
than is commonly understood,” John Maynard Keynes wrote.
“Indeed, the world is ruled by little else.” In 1960,
Chicago’s great economists were convinced that Ronald Coase was
right. His ideas help to rule our world.

(Cass R. Sunstein, the Robert Walmsley University professor
at Harvard Law School, is a Bloomberg View columnist. He is the
former administrator of the White House Office of Information
and Regulatory Affairs, the co-author of “Nudge” and author of
“Simpler: The Future of Government.”)